Source: Groupon.

Groupon (NASDAQ:GRPN)  saw its share price drop by more than 12.7% yesterday as investors reacted negatively to the company's latest earnings report. Although the market tends to overreact to bad news in the short term, the online daily-deals specialist faces considerable challenges as it tries to transform itself and successfully compete against established industry players such as, eBay, and RetailMeNot.

Is Groupon a bargain deal for investors or damaged merchandise?

Selling more deals, but still losing money
Sales during the second quarter came in at $751.6 million, up 23% from the same quarter of last year, but below analysts' forecast of $761.8 million. The company delivered a net loss of $0.03 per share during the quarter, in line with expectations.

Groupon is trying to transform its business via multiple initiatives, but results have been mixed so far. Although sales and some metrics regarding customer demand are clearly moving in the right direction, the company has not translated that growth into improved profitability.

Groupon is expanding into e-commerce via acquisitions such as South Korean online marketplace Ticket Monster and U.S. fashion site Ideeli. Management is also putting a lot of focus on mobile and local deals in order to increase the relevancy and effectiveness of those deals, providing a better service to both customers and merchants.

Groupon wants consumers to see the platform as a fully integrated online marketplace, as opposed to a simple daily-deals site, and there are some encouraging signs to consider.

Active customer count during the quarter increased 25% year over year, to 53.2 million, while gross billings grew 29%, to $1.82 billion.

Source: Groupon.

Nearly 92 million people have downloaded the Groupon mobile app worldwide, and mobile now represents over 50% of the company's business.

Source: Groupon

CEO and Director Eric Lefkofsky said in the earnings conference call that the business is turning the corner in North America, which could be a big positive for investors in the medium term:

The average number of unused Groupons per customer, which is a good indicator of people's willingness to buy more, has declined by more than 25% in the past year. That number has now been stable for the majority of 2014, which leads us to believe that we've seen the bottom.

Carving a niche in a crowded space
Groupon is making progress in several key areas, but the company faces a considerable challenge in consolidating its position in the industry and building a profitable and sustainable business model while competing against a number of rivals.

Amazon is the undisputed king in online retail, willing to sell its products at razor-thin profit margins, or even at a loss, in order to continue gaining market share and outgrow both traditional retailers and online competitors. With this strategy, Amazon puts considerable pressure on profit margins across the industry.

eBay is in the business of matching buyers and sellers of all kinds of products. Unlike Amazon, which is considered a dreaded competitor by most brick-and-mortar retailers, eBay is a commerce facilitator that provides traditional retailers with an opportunity to join the online and mobile commerce revolution via a proven and successful platform.

RetailMeNot in recent years has achieved material success in the coupons business. While Groupon is mostly focused on offering huge discounts from small merchants, RetailMeNot has effectively attracted big companies and coveted brands to its coupons offerings, and this resonates remarkably well among consumers.

Amazon, eBay, and RetailMeNot have different business models, but the three companies have consolidated their position in the industry while providing a valuable proposition to customers and building a sustainable business model.

Groupon's initiatives seem to be gaining some traction among consumers, but the company still needs to prove it can consistently generate sales growth while increasing profitability. This is no easy task, especially when considering that Groupon operates in a highly aggressive and dynamic competitive environment.

Foolish takeaway
Initiatives such as an increased focus on mobile and local deals seem to be generating positive results for Groupon when it comes to increasing its user base, but the company has not yet proven to have the competitive strengths to consitently succeed in such a challenging and dynamic business. Although Groupon seems to be taking steps in the right direction, the company is hardly out of the woods at this stage.